China’s independent refineries brace for feedstock shortage as tax rules change

China’s Shandong independent refineries are bracing for a potential feedstock shortage in the fourth quarter, as they are nearing the end of their crude import quota utilization and face higher cost of alternative feedstocks, owing to a change in consumption tax regulations that are being planned by Beijing.

China’s independent refiners, as opposed to their state-owned counterparts, are allotted annual quotas for crude imports and are also avid users of fuel oil and bitumen blend as feedstock to produce refined products including gasoil and gasoline.

These refiners have a capacity of 3.4 million b/d, accounting for around 18% of total Chinese refining capacity, and have considerable sway over domestic market balances and international oil flows into China.

Starting Oct. 1, Beijing is expected to alter the consumption tax regulation on fuel oil and bitumen blend such that independent refineries will need to bear a higher tax burden that will significantly impact their refining and profit margins, refinery and trade sources told S&P Global Commodity Insights Sept. 13.

Instead of being able to offset all of the consumption tax levied on fuel oil with tax paid on gasoil and gasoline -- that they are then able to pass on to the end-user -- these refiners will now be able to offset only the amount equivalent to the actual yield of gasoil and gasoline, which is typically 60%, and will have to bear the remaining tax burden themselves, sources said, adding that this will raise the cost of processing those feedstocks.

“The economics of using fuel oil and bitumen blend as feedstocks will probably no longer exist if this [tax regulation] is strictly implemented, and refineries will have to cut the imports of those grades accordingly,” said a refinery source.

A Dongying-based independent refinery has currently suspended the procurement of fuel oil because of the possible regulations.

Procurement costs to go up

Although no specific regulations have been released yet regarding the exact yields of gasoil and gasoline that the tax can be claimed against, it is highly likely that this will be significantly lower than 100% currently and the cost of processing fuel oil and bitumen blend will rise, sources said.

The consumption tax on fuel oil/bitumen blend is currently Yuan 1.2/liter ($0.17/liter), or Yuan 1,218 ($171)/mt, and independent refineries are usually able to claim at least 95% of the consumption tax back by deducting from the gasoline and gasoil produced, refinery sources said.

However, under the new regulations, refineries will likely only be able to offset 60% of the consumption tax, meaning they will have to bear a tax burden of around Yuan 426 ($59.8)/mt that cannot be passed on to the end-user, a trade source said, adding that refineries will find it hard to implement cost savings of this level in other areas to protect their margin.

But a second trade source said that the details have not come out yet, so it was a bit early to jump to conclusions.

Refineries without crude import quotas

The higher tax burden will be especially challenging for those refineries without crude import quotas as they have no other good feedstock choices, sources said.

“The incremental cost may be borne by both refiners and the suppliers of the feedstock, but it will mostly be the refiners that will bear the cost which will further squeeze their profits,” said another refinery source.

The average refining margins for processing imported crudes at Shandong independent refineries was around Yuan 206/mt ($3.9/b) in August, up Yuan 179/mt from a month earlier, data from local energy information provider JLC showed.

“But in general it’s becoming difficult for independent refiners to make a profit this year, so the new tax regulations will likely cast more dust on future operations,” said the refinery source.

In the first eight months of the year, Shandong’s independent refineries imported 9.36 million metric tons of fuel oil, stable on the year, data from Commodity Insights showed.

Imports of bitumen blend fell 29.8% to 6.07 Mmt over January-August. Fuel oil and bitumen blend imports accounted for about 20% of the total feedstock imports, the data showed.

Crude import quotas to fall short

Independent refineries that are short of crude import quotas might have to face severe feedstock shortage if the economics of processing the alternative feedstocks deteriorate, which will likely affect their run rates in the fourth quarter, sources said.

“If these refiners cannot find economical alternative feedstocks, they may have to rely on imported crudes and crude import quotas might be used up soon,” said an analyst in Shandong.

China’s 26 qualified refineries with crude import quotas in Shandong have imported a combined 61.31 Mmt (1.84 million b/d) of crudes in the first eight months of the year, leaving only 25.11 Mmt of the quota for the rest of the year, Commodity Insights data showed.

Looking at their crude import volumes in the January-August period, there's a shortfall of more than 5.5 million mt of crude import quotas for the rest of the year.

“The government might allocate the 2025 crude import quotas for independent refineries quite early this year,” said a source with a state-owned oil company on the sidelines of Commodity Insights’ APPEC 2024 conference in Singapore.